The Great Dividend Hunt

By

Brett Arends

Updated Oct. 5, 2012 6:55 p.m. ET

Stocks that pay dividends have been hot lately. But despite the recent rally—the Dow Jones U.S. Dividend 100 Index is up 10% so far this year—there still are some decent opportunities, especially for investors willing to think globally.

ENLARGE

Johnson & Johnson products
Associated Press

One factor driving the boom: Investors now earn paltry rates on bonds and certificates of deposit. The Standard & Poor's 500-stock index, by contrast, carries a yield of about 2.2%, and many stocks pay considerably more. (Yields, which fall as prices rise, are the annual payout as a percentage of a stock's price.)

It might be tempting to think the trend has run its course. Among household-name dividend stocks, utility
American Electric Power
is up 21% from a year ago, tobacco giant
Altria Group
has shot up 28%, and pharmaceuticals company
Pfizer
has jumped 45%.

But while dividend-stock prices have been rising, so have payouts. "Dividends have had a fantastic year and a half," says
Howard Silverblatt,
senior analyst at S&P. Overall, payouts are up 16% so far this year, as companies hand back more of their rising earnings. The third quarter saw record dividend payouts, he says, "and we expect the fourth quarter to beat that."

So where can investors still find reasonable value?

If you are buying stocks for grandma—or anyone who is concerned about income more than capital growth—it makes sense to stick with bigger companies that have strong balance sheets and businesses, especially if the companies operate in many different countries.

Companies in highly cyclical industries—from finance to heavy manufacturing—are probably best avoided, since they can be volatile. The sweet spots are essential services and consumer staples, which tend to sail fairly smoothly in good times and bad.

Money managers on both sides of the Atlantic say three sectors stand out as particularly attractive: pharmaceutical companies, big energy and telecommunications companies. There also might be opportunities in consumer companies and among European-based utilities.

The company has a strong balance sheet and outstanding franchises. Boston fund firm GMO, which has $99 billion under management, had more than 5% of its high-quality U.S. stock portfolio in J&J at the end of August.

The biggest U.S. telecoms,
AT&T
and
Verizon Communications
,
already have risen a long way. You can find better yields elsewhere, especially outside the U.S. But you have to be careful: Some companies are saddled with a lot of debt, declining landline businesses or both. Spain's
Telefónica
,
for example, with a nominal yield of 12%, is a speculative play.

Judy Saryan,
who runs the $980 million
Eaton Vance Tax-Managed Global Dividend Income Fund
,
likes U.K.-based
Vodafone
,
the world's largest operator of cellular networks. (So does Mr. Russell.) Vodafone trades at just 11 times projected per-share earnings for the next four quarters and yields 5%. Its balance sheet is strong, and it is geographically diversified. Vodafone also owns 45% of Verizon Wireless.

Then there's big oil. "Energy remains a fertile sector for income investors," says
Lloyd Glazer,
managing partner of Mayflower Advisors in Boston, which manages $850 million. Once again, the top U.S. companies have risen a long way, and yields have been compressed. "The global companies offer better valuations and higher yields than the domestics," he says.

France's
Total
,
Italy's
Eni
,
Anglo-Dutch
Royal Dutch Shell
and
BP
of the U.K. all boast yields above 4.5%. These stocks are exposed to the global energy market more than the troubled European economy, Mr. Glazer says.

You also can find good opportunities in other sectors. U.S. utility stocks have risen a long way, and Eaton Vance's Ms. Saryan says you may find better opportunities across the Atlantic. One example she cites: British-based
National Grid
,
which also has significant operations in the northeastern U.S., yields 3.5%.

Among big consumer companies,
McDonald's
—whose stock has fallen recently due to sluggish sales growth and some rising capital expenditures—yields 3.4%. Ms. Saryan thinks the stock is a reasonable value at these levels.

British supermarket giant
Tesco
,
whose investors include
Warren Buffett,
stumbled earlier this year on domestic price competition. It yields just over 4%.
Ron Chan,
an analyst at the $240 million Appleseed Fund, says the stock is cheap and the firm's fundamentals are solid.

There are caveats, of course. Stocks aren't bonds. Dividends can be cut. Stock prices can be volatile. Dividends are likely to lose at least some of their tax benefits next year as the Bush-era tax cuts expire. And non-U.S. stocks involve some currency risk, although a falling euro also may help European corporate profits.

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